Valuing a cannabis-related business would not be much different from valuing any other business except that this business is based on a product that is illegal to grow or sell under current federal law.
When valuing a cannabis business, you can often approach the cash flow analysis with the same formula used in many other valuations: Present value of any asset is equal to the cash flow divided by the risk less growth, as shown in Exhibit:
- The critical issue in this industry, though, is the lack of reliable historical cash flow information, which requires the application of a discounted cash flow analysis based on projected performance.
CF1 = cash flow expected in the next period
k = discount rate
g = growth rate (in perpetuity)
As with any business, with a cannabis retail operation or medical dispensary, you have to switch your net income to a cash flow by adding depreciation and taking away capital expenditures. You also have to add (or subtract) your working capital requirements to get to enterprise cash flow and then take away debt service and add loan proceeds. This brings you to cash flow to equity. Nothing changes in the cannabis industry other than to really understand where these numbers come from
Net income after taxes + Depreciation - Capital expenditures Working capital requirements = Enterprise cash flow - Debt service + Loan proceeds = Cash flow to equity
Given that this business has operated in the open — officially legal first in Colorado — for less than a decade and many businesses have been around for only a few months or years, it is no surprise that there are very few reliable benchmarks in the cannabis industry from the point of view of a business valuation. More information is emerging, but it is anecdotal for the most part and very jurisdictional-specific.
Business appraisers have to come up with workarounds in this situation. Look at what investors expect to receive in the public stock market, add in the additional risk of being invested in this industry, and then apply professional judgment. In a more established industry, an investor might be content with a 20-25% return; in this one — with the regulatory oversight of federal, state and municipal authorities and leasing, banking, cash and security issues — the investor might be looking for a 40-50% return (according to a 2014 interview published by Marijuana Business Daily
Thus, a cannabis business valuation is similar to any other in some ways, but the particular issues in the cannabis business can affect the cash flow. Pay close attention to vetting forecasts, taxes affecting the cash flow, the potential liability to the IRS and other risk factors unique to the industry. It is important to recognize that finding a dispensary operator with reliable projections will be unusual.